ReportLinker valued the global digital advertising industry at $350 billion in 2020. In the same report, the market research company forecasted this space will grow at a 13.9% compound annual growth rate to reach a mammoth $786 billion by 2026.
The two main titans of the digital advertising industry are Meta Platforms (META, Financial) and Alphabet's Google (GOOG, Financial)(GOOGL, Financial), which combined have over 50% of the market. These platforms operate with what is called a “walled garden” in that they own the digital billboards which they sell to advertisers.
However, a new movement has begun called the “open internet,” which is set to disrupt traditional advertisers. A major player in this category is The Trade Desk (TTD, Financial), which has recently been in talks with Netflix (NFLX, Financial) as a potential ad partner for its upcoming ad-supported subscription tier. If Netflix chooses The Trade Desk over Google, it could signify a major step forward in breaking the hold of the industry giants.
Netflix entering the ad business
On the April 20, Netflix reported first-quarter results with a surprise loss of 200,000 subscribers. Its shareholder letter stated, “Our revenue growth has slowed considerably as our results and forecast [shows].” The company further stated, “A large number of households sharing accounts, combined with competition, is creating revenue growth headwinds.”
Netflix’s stock took a bloody nosedive at the time and is now down 73% from the all-time highs in October 2021.
There was speculation at the time that Netflix would have to change its business model, and it looks like that is happening. Netflix recently confirmed it will be running an ad-supported subscription tier by the end of 2022. This is game-changing news for connected TV advertising providers, as it means Netflix's 222 million subscribers' attention could be up for grabs.
According to a recent report by the Washington Post, co-CEO Ted Sarandos confirmed Netflix is speaking to multiple potential partners for advertising. In a statement, he said, “We are speaking to all of them,” referring to Google, Magnite (MGNI, Financial), Comcast's (CMCSA, Financial) FreeWheel and of course The Trade Desk.
Why Trade Desk could win
The Trade Desk is a leading programmatic advertising player and a much larger player than smaller companies such as Magnite, even if it's not as big as Google. But more importantly, a board member of The Trade Desk, David Wells, is the former Chief Financial Officer (CFO) for Netflix. This gives The Trade Desk an established relationship to leverage.
Although this is still speculation currently, Netflix was mentioned 35 times in The Trade Desk’s most recent earnings call. Here is a direct quote from Jeff Green, founder and CEO of The Trade Desk:
" I have spent many of the last 10 years publicly predicting that Netflix and nearly everyone else would eventually show ads.
Netflix recently announced that they are likely to make ads a part of their future.
Netflix has done a phenomenal job of preserving an amazing experience for consumers that, at some point, that becomes cost-prohibitive because you have to just keep raising prices.
You may know David Wells, who was the previous CFO of Netflix, joined our Board almost 5 years ago. So we've had a great relationship with Netflix because of him, and I'm extremely optimistic in the potential for us to partner with Netflix "
Financials
The Netflix partnership is still speculation right now, but even without this, The Trade Desk is still a great company in my opinion. It has grown revenues rapidly over the past few years, and in the first quarter of 2022, it generated revenue of $315 million, up 43% from the same quarter last year.
Adjusted Ebitda for the first quarter was $121, up 73% year over year. GAAP net income did decline in the quarter, which was mainly due to a substantial increase in General and Administrative costs.
The Trade Desk operates with a very high gross margin of 81%, which is mainly due to it’s “self service” software platform.
The company has a fortress-like balance sheet with $959 million in cash and no debt.
Is the stock overvalued?
The main issue with the company's stock has historically been its valuation. In order to value the company, I have plugged the latest financials into my valuation model, which uses the discounted cash flow method of valuation. I have forecasted 30% revenue growth per year for the next five years.
In addition, I have forecasted the operating margin to increase steadily over the next five years to 25%, which is the average for the software industry.
Given these assumptions, I get a fair value estimate of $34 per share. The stock is currently trading at $43 per share and thus is 25% overvalued, even despite the recent tech stock selloff due to high inflation and interest rates. Thus, investors who are value-focused may wish to wait for a better entry point.
On the other hand, the stock us significantly undervalued based on the GF Value chart, a unique intrinsic valuation method from GuruFocus that considers historical earnings multiples, past stock returns and analysts' estimates of future business performance.
Final thoughts
The Trade Desk is a tremendous company which is disrupting the $800 billion digital advertising industry. Its business model is strong and recent financial growth is also great. If the Netflix partnership is solidified, that would really be the cherry on top, but since that is still highly speculative, the stock looks overvalued to me at the present.
